10% Annual Returns? How CSX Stock Can Supercharge Your Portfolio (NASDAQ:CSX)

Introduction

It’s time to talk about one of my all-time favorite dividend growth stocks, a company that is not yet a part of my dividend (growth) portfolio.

That company is the CSX Corporation (NASDAQ:CSX), one of North America’s largest Class I railroads and one of the best sources for elevated returns in the past few decades.

Over the past ten years alone, the CSX ticker has returned close to 330%, beating the tech-heavy S&P 500 by more than 100 points!

As I mentioned in almost all railroad articles, the only reason I do not own CSX is the fact that I own three other railroads in a concentrated portfolio of currently 20 dividend (growth) stocks.

• I own Union Pacific (UNP), the company that enjoys a duopoly with Buffett-owned BNSF in the western two-thirds of the United States.
• I have invested in Canadian Pacific Kansas City (CP), the Canadian-based giant with direct exposure in all three North American nations. This railroad comes with significant bulk and merchandise exposure as well, which is an area where CSX shines as well.
• I have invested in Norfolk Southern (NSC), the intermodal-heavy railroad that shares a duopoly with CSX in the East.

The “problem” for me is that I bet on the wrong horse. CSX has been a much better performer than NSC for a number of reasons.

• It has a bigger focus on high-margin bulk and merchandise products, which have been doing much better than consumer-sensitive intermodal shipments.
• One can make the case it has better management, as it has consistently reported better operating metrics. That may also explain why NSC is currently fighting an activist investor. CSX is not.

Essentially, the only reason why I have not switched from NSC to CSX is that I expect NSC to be potentially more undervalued if operations are improved through activist – or independent company measures.

On top of that, I have significant bulk and merchandise exposure through CP and UNP.

That said, CSX just reported its earnings, which were very strong, as the railroad continues to prove that it is able to handle a tricky environment of inflationary pressures and poor demand very effectively.

My most recent article on CSX was written roughly three months ago when I went with the title CSX Stock: Earnings, Risks, And The Road To Elevated Long-Term Gains.”

Since then, shares have been roughly unchanged.

In this article, I’ll walk you through the earnings, discuss what this means for the “bigger picture,” and explain why I have decided that I want to own CSX, even if that means potentially selling NSC (on strength!).

So, let’s get to it!

Why CSX Is Such A Strong Player

I have to say I was mildly nervous going into the company’s earnings.

That’s based on poor numbers and comments from J.B. Hunt (JBHT) earlier this week. JBHT is one of North America’s largest transportation companies. It is the largest owner of intermodal containers and operates tens of thousands of trucks.

During its earnings call, it mentioned both inflationary pressures on costs and deflationary headwinds in pricing. That’s a toxic mix for margins and one result of the current challenging macroeconomic environment.

[…] we continue to face inflationary cost pressures despite also facing deflationary pricing pressure. Our financial performance is not where we want it to be, particularly in Intermodal and our Highway Services. We recognize that some of this is driven by market dynamics, while some is related to our decision to remain committed to our investments to drive future growth. – JBHT 1Q24 Earnings Call

With that in mind, let’s get right to the numbers.

As we can see below, first-quarter revenues were down 1%, with total volumes being up 3%.

The gap between positive volume growth and negative revenue growth was mainly caused by lower fuel surcharges, decreases in “other” revenue, lower trucking revenue, and pricing declines in export coal due to the impact of lower benchmark rates.

Looking at the company’s various segments, we find interesting developments.

For example, merchandise revenues saw a 1% increase despite flat volumes.

According to the company, positive momentum was seen in specific sectors, with automotive, chemicals, and forest products showing growth.

To be more specific, automotive sector revenues accelerated after a slow start, driven by increased production at several manufacturing plants.

Meanwhile, chemicals, the largest market, continued to gain momentum, mainly driven by plastics, food, and NGLs. NGLs stand for natural gas liquids.

I’m extremely bullish on NGL production in the United States, especially as major oil basins are starting to see a lower quality of oil output (more by-products like NGLs).

Between 2010 and 2023, NGL production in the United States has more than tripled.

CSX has a subsidiary and many assets to support the growing supply and demand for NGLs.

Continued expansion of distribution terminals on the CSX network will provide growth as shale gas becomes more readily available and pipelines face constraints. CSX works with LPG producers, refiners and receivers to offer safe, streamlined transportation services. – CSX

Moreover, despite challenges in metals and finished steel, the company saw opportunities for sequential improvement in the back half of the year.

The agriculture and food sector remained soft due to global soybean supplies and the high availability of local crops. In this segment, the company also expects normalization in the second half of this year.

As we can see above, merchandise accounted for 59% of total revenue, with $3,388 revenue per unit.

The only segment with similar margins is coal, which brought in $3,362 in revenue per unit.

In the first quarter, total coal shipments were relatively flat, with a bigger focus on exports.

According to the company, it was able to quickly divert coal shipments after the bridge collapse in Baltimore, which I discussed in this article.

The revenue impact per month due to the port closure was estimated to be between $25-30 million, including the benefit of diverting some tons.

While congestion is expected to persist, we could be looking at a reopening of the port at the end of May.

That said, while current natural gas prices are a headwind for coal, I’m long-term bullish on coal, even if domestic demand is in a steep secular decline.

Peabody Energy (BTU), one of America’s largest coal producers, estimates that global thermal coal demand will continue to rise, with pressure on supply. This is beneficial for pricing and export demand and one of the reasons why I actually like it when railroads have significant coal exposure.

In fact, CSX has just 14% intermodal exposure, with the majority of its revenue coming from goods with secular growth tailwinds.

As I expect inflation will likely remain sticky on a prolonged basis, CSX makes more sense in my portfolio than an intermodal-heavy company like Norfolk Southern. NSC had 25% intermodal exposure on a 2023 full-year basis.

Speaking of intermodal, this segment did quite well, as revenue increased by 1%, driven by 7% higher volumes.

According to CSX, the international intermodal business showed strong growth due to healthy consumer demand and more normalized inventories. This led to higher import levels.

It also saw domestic intermodal growth, albeit at a slower pace.

Moreover, the company was happy with its service levels, which allowed it to win business in this segment – especially in light of rail vs. truck competition.

What’s been constant is our service performance, which continues to help us win new business and drive truck conversion even as the weak truck market conditions persist. We’re optimistic that truck capacity will normalize in time, even benefit the intermodal market. More importantly, we are confident that we will be prepared when the demand rebounds. – CSX 1Q24 Earnings Call

In general, the company maintains strong service levels, as efforts to improve terminal performance have led to significant declines in dwell time and improved the capacity for converting shipments from truck to rail.

Despite slight declines, carload trip compliance remains above 80%, with ongoing improvements in the second quarter.

On top of that, the railroad benefits from the ongoing trend of supply chain re-shoring, which I have discussed in countless articles, including my prior CSX article.

According to CSX, the industrial development program reported a strong project pipeline with a significant total capital investment of $4.2 billion.

These projects include various sectors, including electric vehicle manufacturing, minerals, metals, and chemicals.

Even better, as we can see above, 80% of investments cover new sites, with more than 500 new projects in the total development pipeline.

Needless to say, CSX is very upbeat about what this means for future growth:

We expect our merchandise business to gain momentum through the year as effects from new business wins, truck conversions, and the ramp-up of industrial development projects build on a favorable trends in many of our end markets. We look for steady growth in intermodal, supported by stable consumer demand and more normalized retail inventories, which are driving improved port activity. – CSX 1Q24 Earnings Call

Shareholder Value & Outlook

With all of this in mind, 1% lower revenues met 4% higher costs. This reduced operating income by 8% to $1.4 billion. The operating margin declined by 270 basis points to 36.8%.

Interestingly, CSX did not mention the operating ratio, which is the inverted operating margin. While the operating margin is basically the same, the company mentioned the operating ratio not once during its earnings call. It also replaced the OR with operating margins in its presentation slides.

While it saw major cost increases in areas like labor, it was able to achieve higher productivity, which will likely benefit the company going forward.

Net earnings were down 10%.

Furthermore, 1Q24 free cash flow was $560 million. That’s down from $816 million in 1Q23.

The company used this cash to distribute $235 million in dividends.

• CSX currently yields 1.4%.
• It has a very low payout ratio of just 24%.
• The five-year dividend CAGR is 8.5%.

The payout ratio is so low because CSX is a buyback-focused company.

While 1Q24 buybacks were subdued, it usually spends most of its free cash flow on buybacks, repurchasing 35% of its shares in the past 10 ten years alone.

This is what the company said with regard to buybacks and dividends in 1Q24:

We also believe a long-term focus on economic profit aligns our interest with that of our shareholders. While first-quarter economic profit declined due to previously mentioned discrete headwinds, we expect it to increase over time as we efficiently convert freight off the highway while maintaining strong asset utilization and attractive returns on our capital spending. – CSX 1Q24 Earnings Call

In light of these upbeat words, CSX reiterated its guidance for the full year 2024, expecting total volume and revenue growth in the low to mid-single-digit range.

The company also expects momentum in its merchandise business throughout the year, driven by new business wins, truck conversions, and industrial development projects.

Moreover, steady growth in intermodal is expected, supported by stable consumer demand and improved port activity.

This bodes well for its valuation.

CSX currently trades at a blended P/E ratio of 18.1x, which is slightly above its long-term normalized P/E ratio of 17.4x.

This year, analysts expect 6% EPS growth, potentially followed by 12% and 9% growth in 2025 and 2026, respectively.

This implies an annual return of 9%, including its 1.4% dividend.

Since early 2004, CSX has returned 15.9%.

These numbers also imply a fair price target of roughly $42, which is 23% above the pre-earnings stock price. The consensus target is $40.

Based on this context, I stick to my Buy rating and will consider buying CSX for my portfolio, as I believe this railroad business perfectly fits my strategy.

I just haven’t figured out if I want to sell NSC, as I believe it’s a business with tremendous potential once management improves operating metrics.

On top of that, with the intermodal tailwinds that CSX sees, I expect that NSC could benefit from that as well.

Needless to say, the main takeaway here is that CSX remains on track to deliver elevated long-term capital gains, as it confirmed to shine in both good and challenging economic times.

Takeaway

CSX continues to impress with its resilience and operating performance, reaffirming its position as a top-tier dividend growth stock.

Despite facing headwinds like inflationary pressures and deflationary pricing, CSX navigated these challenges very effectively.

With a diversified revenue stream and a focus on high-margin segments, CSX stands out as a reliable investment option for long-term growth.

As the company maintains its momentum and strategic initiatives, I believe the company is in a great spot to generate long-term value.

For me, CSX represents an enticing opportunity, albeit with the dilemma of potentially divesting from Norfolk Southern, as I don’t want to own four railroads in a highly concentrated portfolio.

Pros & Cons

Pros:

• Resilient Performance: CSX has shown its ability to thrive in challenging economic conditions.
• Strategic Focus: The company’s strategic focus on high-margin products, such as bulk and merchandise, provides a solid foundation for sustainable growth.
• Re-Shoring: CSX is one of the main beneficiaries of economic re-shoring, with a massive pipeline of projects in its operating area.
• Shareholder-Friendly: CSX’s commitment to shareholder value through initiatives like buybacks and dividends reflects a strong alignment with investor interests.

Cons:

• Market Dynamics: CSX operates in a highly cyclical industry. This comes with recession risks.
• Competition: Competition within the transportation sector, mainly from other railroads and trucking, could hurt its growth.
• Potential Risks: While CSX has navigated challenges effectively, there are risks associated with its operations, including regulatory changes, operational disruptions, and macroeconomic uncertainties.